Computing Price Adjustment in Construction Contracts: The Limited Scope for Setting Aside an Arbitral Award

[Zacarias Kanjirath Joseph is a dispute resolution lawyer based in Bombay. He may be contacted at [email protected]. The views expressed in this piece are personal]

A division bench of the Supreme Court of India in its judgment dated 8 May 2019 in Ssangyong Engineering & Construction Co. Ltd. v. National Highways Authority of India set aside an award of an arbitral tribunal, which permitted the National Highways Authority of India (NHAI), a government undertaking, to pay reduced amounts as ‘price adjustment’ to Ssangyong under a construction contract.[1] This reduced ‘price adjustment’ was consequent to the arbitral tribunal reading into the existing contract, a policy circular and certain guidelines issued by a ministry of the Government. This circular and guidelines changed the formula for determining the ‘price adjustment’ agreed between the parties under the underlying contract. The Supreme Court held that such an imposition of terms not agreed between the parties ‘shocked the conscience of the Court’ and set aside the award on the ground of it conflicting with the fundamental policy of India. Whilst doing so, the Supreme Court discussed the meaning and scope of various grounds for setting aside an arbitral award under section 34 of the Arbitration and Conciliation Act, 1996 (as amended).

Facts

NHAI accepted Ssangyong’s bid for construction of a four-lane by-pass project in Madhya Pradesh, India. The contract between the parties specified that price adjustment (variable price) was payable to Ssangyong for components such as: labour, plant and machinery, petroleum, oil and lubricant (POL) etc. used by Ssangyong. A formula was specified for calculation of the price adjustment for these components. The formula was linked to the Wholesale Price Index (WPI), published by the Ministry of Industry and Development at the relevant time. For a period of one year after execution of the contract, the WPI applicable was that which was published by the Ministry for the years 1993-1994 = 100 (the Old Series). The Ministry of Industry and Development issued a new series of WPI from 14 September 2010 (the New Series). From 2010 through February 2013, payments were made by the NHAI to Ssangyong in accordance with the New Series. However, in February 2013, the NHAI issued a Policy Circular in which a new formula for determining WPI was used by applying a “linking factor” based on the WPI in the Old Series. The NHAI sought to apply the Circular to the contract in question, as a result of which a linking factor was determined by which the WPI in the Old Series was ‘linked’ to the New Series. This substantially reduced the price adjustment payable by the NHAI to Ssangyong.

Ssangyong accordingly approached the Dispute Adjudicating Board (DAB) under the dispute resolution clause of the contract, challenging the application for the Circular to the contract in question. By a 2:1 majority, the DAB ruled in favour of the NHAI, recommending a certain linking factor, and accordingly arrived at the figures of price adjustment to be paid to the Ssangyong.

Aggrieved by the decision, Ssangyong approached the arbitral tribunal consisting of three members. The question before the arbitral tribunal was whether the price adjustment would continue under the terms of the contract, or whether the Circular dated 15 February 2013, applying the linking factor, would have to be applied. The arbitral tribunal, by way of a 2:1 majority, agreed with the NHAI’s contentions and held that the Circular could be applied as it was within contractual stipulations. While doing so, the majority award applied certain Government guidelines published on the website of the Ministry of Commerce and Industry, which were not placed on record during the hearings before the arbitral tribunal.

This award of the arbitral tribunal was challenged by Ssangyong under section 34 of the Arbitration Act. The same was dismissed by the single judge and division bench of the Delhi High Court, which held that the majority’s view was a possible one and hence did not warrant interference. Hence, Ssangyong approached the Supreme Court.

Ruling

The Supreme Court first examined whether the 2015 amendment to the Arbitration Act would be applicable to the present section 34 petition. This question arose because, while the petition challenging the award was lodged after the amendment, the arbitral proceedings commenced prior to the amendment. The Court noted that despite the relevant amended provisions being clarificatory since they changed the position of law, it could not be applied retrospectively. The Supreme Court relied on its earlier judgment in BCCI v Kochi Cricket Private Limited to hold that the amended section 34 would only apply to petitions filed after 23 October 2015, being the date when the amendments to the Arbitration Act came into force.

Ssangyong further contended that the arbitral award contained “errors of jurisdiction” as it concerned decisions on matters beyond the scope of the submission to arbitration. It was submitted that the arbitral tribunal’s reference to the guidelines of the Ministry of Commerce and Industry, and the application of the clauses of the Circular to the present contract, were outside the scope of the arbitral reference. The Supreme Court negatived this contention on the ground that “errors of jurisdiction”, consequent to a mere misinterpretation of a contract, cannot be said to fall foul of the provision of section 34(2)(a)(iv) of the Arbitration Act (award on matters beyond the scope of the submission to arbitration). The Supreme Court held that such a misinterpretation of the contract could be said to have been fairly comprehended as “disputes” submitted within the arbitration agreement, and therefore it cannot be said to be an error of jurisdiction.

The Court then clarified the meaning and scope, after the amendment, of the phrase “public policy of India” as a ground for challenging an arbitral award. It held that a domestic award would be set aside on this ground, if it were contrary to (i) the fundamental policy of Indian law or (ii) if it were against the basic notions of justice or morality. The Court confirmed its earlier interpretation of the phrase “public policy”, in paragraphs 18 and 27 of its judgment in the case of Associate Builders v. DDA, (2015) 3 SCC 49, where it was held that an award would be said to be contrary to the fundamental policy of Indian law if for instance, it were to disregard the binding effect of the judgment of a superior court. However, the mere fact that an award may be contravening a statute not otherwise linked to public policy or public interest, cannot be said to be in contravention of the public policy of India.

The understanding of “conflict with justice or morality” was understood as meaning a conflict with the “most basic notions of morality or justice”. An award can be said to be against justice only when it shocks the conscience of the court. An award would be said to be against morality if it were such that are not illegal per se but would not be enforced given the prevailing mores of the day. However, interference on this ground would also be only if something shocks the court’s conscience. This is consistent with the ruling of the Supreme Court in paragraphs 36 to 39 of the Associate Builders case.

In light of the above reasoning, the Supreme Court ruled that Ssangyong’s challenge to the arbitral award on the ground that the arbitral tribunal re-wrote the terms of the contract between the parties, conflicted with the “public policy of India”, as it contravened the “most basic notions of justice”. This was because (i) the contract clearly stipulated the application of the formula as dependent on the WPI at the relevant time (and not the application of the ‘linking factor’); and (ii) the Circular could not be binding on the other party without its consent, especially when the Circular itself required the consent of the other party. The Court held that by substituting a workable formula under the agreement by another formula de hors the contract between the parties, the arbitral award created a new contract between the parties. This was held to be contrary to fundamental principles of justice as followed in this country, and a shock to the conscience of this Court. The Court however made it clear that this ground was available only in exceptional circumstances and the court could not interfere with an award on the ground that justice has not been done in the opinion of the Court.

Lastly, the Supreme Court upheld the contention of the Ssangyong that the ground of section 34(2)(a)(iii) of the Arbitration Act (party unable to present case before the tribunal) would include situations where materials are considered without being brought on record by the parties before the Tribunal. This was because the parties have had no opportunity to comment on such material. The Court therefore held that the arbitral tribunal’s application of the guidelines of the Ministry of Commerce and Industry, which were not filed by the parties, was in violation of section 34(2)(a)(iii) of the Arbitration Act since SsangYong was not given the opportunity to address arguments on the same. The Court held that, if given the chance, SsangYong could have argued as to which of the linking methods was preferable, which the Tribunal concluded on its own.

On these grounds, the Supreme Court set aside the majority arbitral award. Further, the Court noted that under the scheme of section 34 of the Arbitration Act, the dispute between the parties would have to be referred afresh to another arbitration, after setting aside a precious arbitral award between the parties. The Court however observed that such a fresh reference would cause huge delay, and in order to give effect to the object of the Arbitration Act, i.e., speedy resolution of the disputes, the Supreme Court invoked its powers under Article 142 of the Constitution and upheld the minority Award which had awarded the entire claim to the Ssangyong.

Comment

The decision is consistent with the recommendations of the Law Commission of India that prefaced the enactment of the 2015 amendment to the Arbitration Act. The Law Commission had observed that the ground “public policy of India” (in its pre-amendment formulation) was expansively interpreted by the Supreme Court in its judgments in the cases of ONGC Limited v Western Geco International Limited [(2014) 5 SCC 12] and ONGC Limited v Saw Pipes Limited [(2003) 5 SCC 705]. These judgments included various grounds of interference such as, inter alia, the (i) contravention with substantive Indian law; (ii) the requirement of a ‘judicial approach’ by an arbitral tribunal; (iii) non-compliance with Wednesbury principles of administrative law. These grounds of interference have been done away with. With this judgment, it may be stated that the additional grounds laid down in the previous rulings of the Supreme Court in the Western Geco and Saw Pipes case have been statutorily superseded by the amendment to the Arbitration Act.

The Supreme Court has held that the ground of conflict with the “public policy of India”, includes within its sweep only two facets: (i) conflict with the fundamental policy of Indian law or (ii) if it were against the basic notions of justice or morality. Illustratively, the Supreme Court has held that an arbitral award’s alleged contravention of a statute would only merit a courts interference if such statute were to be linked to the public policy of the country. Similarly, the non-consideration or ignorance of binding precedents of a superior court by an arbitral tribunal also falls within the scope of the challenge on this ground. Additionally, the reliance by an arbitral tribunal on material on which parties have not had an opportunity to comment also merited the interference of the court. The restriction of the grounds of interference is welcome, as courts would now be circumspect in exercising their discretion to set aside arbitral awards.

At its core, however, is the principle that government entities are not entitled to impose terms consequent to change of policy in matters of contract. The Supreme Court in clear terms has held that even the Government would be bound by cardinal principles of contract law requiring the consent of the other party, prior to the novation of a contract between the parties.

Zacarias Kanjirath Joseph

[1] Price adjustment is a modification made to the overall price of a contract to take account of legitimate changes in the costs of performing the contract. It is a mechanism to protect both buyers and sellers from unforeseeable input price fluctuations.

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